MARKET CHAOS: A THREAT TO LNG

Clara Tan - Jan 26, 2021

A dramatic rally in Asian LNG spot prices that began in late November is beginning to recede, but the episode of extreme volatility could have profound consequences for the fuel's future. The question is how badly LNG's reputation as a reliable and affordable source of energy has been marred for large Asian consuming nations, many of which are reshaping energy policies in line with new net-zero decarbonization targets. Several LNG export projects are now in a holding pattern, waiting for buyers to make long-term offtake commitments before moving ahead. Price spikes are not helpful for the LNG industry, which has been trying to expand its market by projecting itself as an abundant, affordable and flexible fuel that is compatible with the energy transition.

Asian spot prices were relatively stable up until recently, averaging in the range of $4-$7 per million Btu in 2019-20. However, the spike prompted the priciest known deal at almost $40/MMBtu. Although prices have since eased, the rally underscored how vulnerable LNG prices are to liquidity constraints, extreme weather and headlined deals -- a situation that is hardly reassuring to emerging buyers in Southeast Asia and South Asia looking to displace liquids and coal with LNG for cleaner electricity supplies.

The LNG price shock coincides with net-zero carbon emissions pledges recently announced by China, Japan and South Korea, which are trying to kick their addictions to coal. It remains to be seen if recent volatility in LNG markets will either prompt them to reconsider coal or drive them more toward renewables.

A combination of power shortages and low LNG inventories led Japanese utilities to boost coal-fired power generation, prompting concerns that policymakers in Tokyo could revisit previous coal clampdown targets. Japan aims to phase out 100 old coal-fired plants by 2030, which could boost LNG's prospects, but the government could also opt to accelerate blending coal with ammonia at coal power plants or revive a push for nuclear restarts.

Discussions are now under way on updating Japan’s energy policy, but sources say there is no turning back on Tokyo's 2050 net-zero pledge. Surprisingly, that pledge has been well received by domestic industrial firms such as Nippon Steel, which recently announced its own net-zero target (PIW Nov.6'20). An analyst notes that Tokyo's coal target implies that coal plants "would be off the grid but will remain without decommissioning.”

Renewables are already slated to get a major boost in Japan's policy, while politicians have so far shunned discussions on restarting idle nuclear reactors due to public sensitivity. Tokyo policymakers could decide to strengthen the kind of national energy security that comes from having spare capacity and infrastructure such as storage, fuel switching, fuel diversification and domestic production.

Unlike mature US and European markets, Asia lacks the storage tanks, berths and pipelines needed to deal with a crisis. In Japan and South Korea, storage capacity is generally reserved for incumbents.

Buyer Responses

Buyers are expected to reassess their portfolios and procurement strategies for handling a demand crisis in light of the price surge. In the near term, they may shift more toward short-term deals and strip cargoes with delivery spanning several months and prices linked to oil. Some could seek comfort from new long-term deals, since the oil slopes -- the factor used in such contracts to convert oil prices to gas prices -- have dropped to competitive levels. Others may be hesitant about making long-term commitments, in order to cut exposure to future volatility.

Market liquidity should increase when uncontracted volumes become available from Arctic LNG-2, LNG Canada and Golden Pass, Russian and North American LNG projects that are due to startup in 2023-24. Long-term deals come with other risks such as take-or-pay obligations that can be challenging for buyers facing demand uncertainties. One buyer argues that long-term contracts are typically not flexible enough to respond to demand spikes, and a better approach would be maximizing term volumes and reselling them when demand does not materialize.

A key signpost will be whether Qatar sanctions its delayed four-train expansion in 2021. If that happens early this year, buyers would be in no rush to sign long-term deals, Wood Mackenzie reckons.

LNG spot prices are known to be volatile and weather-driven, but this has been amplified by unplanned production outages that curbed liquidity and emboldened by a few headlined high-priced deals. The entry into LNG markets of new participants such as commodity traders and financial players has improved liquidity in recent years, but they have also contributed to volatility loathed by buyers. Buyers typically view commodity traders as speculators rather than long-term players, as they often trade in physical LNG according to their paper positions and don't invest in the LNG value chain, although this is changing as Trafigura and Vitol receive their first long-term LNG supply from Cheniere.

Trafigura was the buyer of a $39.30/MMBtu cargo, which was resold to a Northeast Asian buyer. Key to boosting liquidity is expanding LNG to new markets and sectors and boosting uncontracted LNG supplies. While deep-pocketed Western majors such as Royal Dutch Shell and Exxon Mobil are willing to sanction projects without firm long-term deals, this risks putting more supply in the hands of a few players.

Clara Tan is the Bureau Chief of Energy Intelligence’s Singapore office, which covers Asia-Pacific's energy developments. Her own focus is on gas/LNG pertaining to corporate strategies, market trends, LNG and regasification projects and government policy.